Defining Incoterms and Their Impact on Total Landed Cost

The International Chamber of Commerce published the first set of International Commercial Terms, or Incoterms, in 1936 to standardize the business vocabulary used in global trade markets.

What Are Incoterms?

The Incoterms are trade terms that clarify responsibilities in the shipment of goods internationally for documents, licenses, port fees, carriage, insurance, terminal costs, duties, delivery fees, and all other expenses within a multinational transaction. Each term is represented by a three-letter acronym.

The ICC has amended and modernized these rules several times throughout history. The current Incoterms definitions were revised and published in 2010 to reflect the current international trade practices. The ICC is scheduled to publish an update again in 2020.

How Are Incoterms Used?

The purpose of the Incoterms is to:

Eliminate barriers caused by distance, language, and local business practices in global business dealings
Diminish uncertainties and conflicting interpretations of trade terms on a worldwide scale
Reduce the risks, delays, and disruptions caused by misunderstandings, disputes, and litigation
Provide a universal vocabulary accepted by all of the major international financial institutions
Minimize problems at critical points

A major critical point occurs within the exchange at the point when the seller’s responsibility ends and the buyer’s responsibility for the shipment begins. This includes the hand-off of costs, risks, and documents. A misunderstanding of responsibility at a critical point will delay a shipment, cause customs problems, and impact the letter of credit payment.

The Incoterms spell out which party has responsibility for:

Risk of loss
Delivery
Export/import licenses
Customs clearance
Contract of carriage
Contract of insurance

The Incoterms do not deal with:

Transfer of property rights in the goods (title)
Relief from obligations and exceptions from liability in cases of unexpected or unforeseeable events
Consequences of various breaches of contract except those relating to the passing of risks and costs when the buyer is in breach of its obligation to accept the goods or to nominate a carrier under the F group of Incoterms

How are Incoterms Structured?

The 2010 version of the Incoterms includes 11 terms segmented into four main groups:

E- Departure

EXW – Ex-Works: The goods are made available for pickup by the seller. The buying organization is responsible from pickup to delivery for all costs and risks of loss or damage.

F – Main Carriage Unpaid

FOB – Free on Board (…named port of shipment): The seller delivers the goods onboard the ship and clears them for export. From that point, the buyer bears all costs and risks of loss or damage.

FCA – Free Carrier (…named place of delivery): The seller delivers the goods, cleared for export, to the carrier selected by the buyer. From that point, the buyer bears the costs and risks of moving the goods to destination. The seller loads the goods if the carrier pickup is at the seller’s.

FAS – Free Alongside Ship (…named port of shipment): The seller delivers the goods to the origin port. From that point, the buyer bears all costs and risks of loss or damage.

C – Main Carriage Paid

CFR – Cost and Freight (…named port of destination): The seller clears the goods for export and pays the costs of moving the goods to destination. The buyer bears all other costs and risks of loss or damage.

CIF – Cost, Insurance, and Freight (…named port of destination): The seller clears the goods for export and pays the costs of moving the goods to the port of destination as well as the insurance. The buyer covers all other costs and all risks of loss or damage.

CPT – Carriage Paid To (…named place of destination): The seller pays for moving the goods to the destination. From the time the goods are transferred to the first carrier, the buyer incurs costs and risks of loss or damage.

CIP – Carriage and Insurance To (…named place to destination): The seller pays for moving the goods to the destination as well as the insurance. From the time the goods are transferred to the first carrier, the buyer incurs costs and risks of loss or damage.

D – Delivered

DAT – Delivered at Terminal (…named terminal at port or place of destination): The seller delivers when the goods are placed at the buyer’s disposal on the arriving means of transport ready for unloading at the named port or place of destination.

"Terminal” includes any place, including a quay, warehouse, container yard, road, rail, or air cargo terminal. The seller bears costs and all risks involved in bringing the goods to and unloading them at the terminal at the named port or place of destination.

DAP – Delivered at Place (…named place of destination): The seller delivers when the goods are placed at the buyer’s disposal on the arriving means of transport ready for unloading at the named place of destination. The seller bears all costs and risks of moving the goods to the named place.

DDP – Delivery Duty Paid (…named place): The seller delivers the goods, cleared for import, to the buyer at the destination. The seller bears all costs and risks of moving the goods to destination, including the payment of customs duties and taxes.

The Incoterms need to be followed by a so-called "named point,” such as a port or place. The terms are specific per mode of transportation.

Term		Named Point	Mode	Example
EX Works	EXW	Place of Origin	All	EXW – Edison
Free Alongside Ship	FAS	Port of Origin	Sea	FAS – Rotterdam
Free On board	FOB	Port of Origin	Sea	FOB – Rotterdam
Free Carrier	FCA	Place of Origin	All	FCA – Fdison
Cost and FReight	CFR	Port of Destination	Sea	CFR – Newark
Cost, Insurance and Freight	CIF	Port of Destination	Sea	CIF – Newark
Carriage Paid To	CPT	Place of Destination	All	CPT – Dallas
Carriage and Insurance Paid to	CIP	Place of Destination	All	CIP – Dallas
Delivered At Place	DAP	Place of Destination	All	DAP – Dallas
Delivered At Terminal	DAT	Place of Port	All	DAT – Melbourne
Delivered Duty Paid	DDP	Place of Destination	All	DDP – Peking

How Do I Select the Appropriate Incoterm?

Many organizations with little experience in international logistics tend to rely on their international suppliers to manage the process.

As they become more familiar with international shipping, the organizations may move from DDP (Delivered Duty Paid) to the next Incoterm, DAT (Delivered At Terminal), and then move on up and through the Incoterms, taking on more responsibility for the shipments.

This progression offers the buying organization the opportunity of negotiating the various rates included in the Incoterms.

In selecting an Incoterm, the buying organization may also consider:

The amount of control it wants
The buyer-seller relationship
Origin and destination country’s customs
Accounting department’s ability to handle foreign exchange transactions
Physical presence in the country of origin
Contract of carriage rates

The buying organization should take precautions:

Attach a formal explanation of the Incoterm selected to the contract or purchase order
Request a confirmation of acceptance of all responsibilities of that Incoterm from the supplier/customer
Draft a checklist of all duties and rights under the selected term and ensure that all transactions are met and nothing is omitted
Request that the supplier/customer also create a checklist
Exchange checklists
Request that the supplier/customer change or add nothing or as little as possible to the selected term
Require signed acceptance in the event that a change or addition is required

How Do Incoterms Impact Total Landed Cost Calculations?

When the Ex-Works Incoterm is selected, the importer of record incurs all of the logistics costs from the supplier’s dock to its own delivery point. All of these costs are then added to the unit price and become the total landed cost.

If the Delivered Duty Paid Incoterm is selected, the supplier incurs all of the logistics costs from its own dock to the buying organization’s delivery location. The buying organization should be billed at the unit price times the number of units shipped. However, it is important to identify if the various logistics costs have, in fact, been added to the unit price.

At the critical point of a selected Incoterm, the seller’s costs end and the buying organization’s costs begin. These costs need to be added onto the unit price to identify total landed costs.

It is critical for an organization to accurately capture its costs from the critical point through to delivery to ensure an all-inclusive selling price. A more in-depth explanation of each of the Incoterms can be found in the International Chamber of Commerce publication Incoterms 2010.